Tag Archives: central banks

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The response of the exchange rates of emerging markets and their equity markets to the Federal Reserve’s “taper,” i.e., reduction in asset purchases, continues to draw comment (see, for example, here). Most analysts agree that these economies are in better shape to deal with capital outflows than they were in the past, and that the risk of another Asian-type crisis is relatively low. But that does not mean that their economies will react the way we expect.

Gavyn Davies of Fulcrum Asset Management, who has a blog at the Financial Times, has posted the transcript of a “debate” he organized with Maurice Obstfeld of UC-Berkeley, Alan M. Taylor of UC-Davis and Dominic Wilson, chief economist and co-head of Global Economics Research at Goldman Sachs, on the financial turbulence in the emerging markets. “Debate” is not the best word to describe the discussion, as there are many areas of agreement among the participants. Obstfeld points out that there are far fewer fixed exchange rate regimes in today’s emerging markets, and many of their monetary policymakers have adopted policy regimes of inflation targeting. Moreover, the accumulation of foreign exchange by the central banks leaves them in a much stronger position than they were in the 1990s. Taylor adds fiscal prudence and less public debt to the factors that make emerging markets much less risky.

But all the participants are concerned about the winding down of the credit booms that capital inflows fueled. Wilson worries about economies with current account deterioration, easy monetary policy, above-target inflation, weak linkages to the recovery in the developed markets and institutions of questionablestrength. He cites Turkey, India and Brazil as countries that meet these criteria. Similarly, Taylor lists countries with relatively rapid expansion in domestic credit over the 2002-2012 period, and Brazil and India appear vulnerable on these dimensions as well.

Another analysis of the determinants of international capital flows comes from Marcel Förster, Markus Jorra and Peter Tillmann of the University of Giessen. They estimate a dynamic hierarchical factor model of capital flows that distinguishes among a common global factor, a factor dependent on the type of capital inflow, a regional factor and a country-specific component. They report that the country component explains from 60 – 80% of the volatility in capital flows, and conclude that domestic policymakers have a large degree of influence over their economy’s response to capita flows.

But are “virtuous” policies always rewarded? Joshua Aizenman of the University of Southern California, Michael Hutchison of UC-Santa Cruz and Mahir Binici of the Central Bank of Turkey have a NBER paper that investigates the response in exchange rates, stock markets and credit default swap (CDS) spreads to announcements from Federal Reserve officials on tapering. They utilize daily data for 26 emerging markets during the period of November 27, 2012 to October 3, 2013. They looked at the response to statements from Federal Reserve Chair Ben Bernanke regarding tapering, as well as his comments about the continuation of quantitative easing. They also looked at the impact of statements from Federal Reserve Governors and Federal Reserve Bank Presidents on these topics, as well as official Federal Open Market Committee (FOMC) statements.

Their results show that Bernanke’s comments on winding down asset purchases led to significant drops in stock markets and exchange rate depreciations, but had no significant impact on CDS spreads. There were no significant responses to statements from the other Fed officials. On the other hand, there were significant responses in exchange rates when Bernanke spoke about continuing quantitative easing, as well as to FOMC statements and announcements by the other policymakers.

The countries in the sample were then divided between those viewed as possessing “robust” fundamentals, with current account surpluses, large holdings of foreign exchange reserves and low debt, and those judged to be “fragile” due to their current account deficits, small reserve holdings and high debt. Bernanke’s tapering comments resulted in larger immediate depreciations in the countries with current account surpluses as oppose to those with deficits, more reserves and less debt. Similarly, Bernanke’s statements led to increased CDS spreads in the countries with current account surpluses and large reserve holdings, while lowering equity prices in countries with low debt positions. The immediate impact of the news regarding tapering, therefore, seemed to be tilted against those with strong fundamentals.

The authors provide an explanation for their results: the robust countries had received larger financial flows previous to the perceived turnaround in Fed policy, and therefore were more vulnerable to the impact of tapering. Moreover, as the change in the Federal Reserve’s policy stance was assimilated over time, the exchange rates of the fragile nations responded, and by the end of the year had depreciated more than those of the more robust economies. Similarly, their CDS spreads rose more. By the end of 2013, Brazil, India, Indonesia, South Africa and Turkey had been identified as the “Fragile Five.”

What do these results tell us about the impact on emerging markets from future developments in the U.S. or other advanced economies? There may be a graduated response, as the relative standings of those nations that have attracted the most capital are reassessed. However, if capital outflows continue and are seen as including more than “hot money,” then the economic fundamentals of the emerging markets come to the fore. But financial markets follow their own logic and timing, and can defy attempts to foretell their next twists and turns.

High Road, Low Road

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Among the many thorny issues that would arise if Scotland were be become an independent nation is the question of its choice of a currency. The first minister of Scotland claims that an independent Scotland would continue to use the pound. But Mark Carney, the governor of the Bank of England, has raised several caveats and stipulations—including limitations on fiscal autonomy—that would be required if a currency union were to be formed. Moreover, British elected officials have thrown cold water on the idea. And that could be a problem for an independent Scotland, as there is no obvious good alternative.

Scotland could unilaterally decide to continue using the pound, just as Panama and Ecuador use the U.S. dollar. But dependence on the United Kingdom for its money is not fully compatible with political independence. Nor is it congruent with the international status that the new country would undoubtedly seek.

How about adopting the euro? Scotland would join the current 18 members of the Eurozone, and would have to hope that it did not suffer from any Scotland-specific shocks. Optimal currency theory spells out the alternative mechanisms a country needs to address an asymmetric shock: mobile labor, flexible prices and wages, and/or a fiscal authority that can direct funds to the area facing the shock. The sight of Irish, Spanish, etc., workers leaving their respective homelands in search of work outside of Europe has hardly been reassuring to prospective members. The Baltic states have shown that prices and wages will fall in response to a policy of austerity, but the economic cost is severe. And no Scottish government would survive the harsh policy conditions attached to the financial assistance extended to Greece, Ireland and Portugal by their European partners and the IMF. Joining the Eurozone at this stage of its existence would not be consistent with Scottish canniness.

If Scotland can not—or will not—join an existing monetary union on terms it deems acceptable, should its create its own currency? The prospect of a Scottish currency has drawn a fair amount of comment: see, for example, here and here and here. A study by Angus Armstrong and Monique Ebell of the National Institute of Economics and Social Research makes the point that the viability of an independent currency for the country would depend on the amount of sovereign debt the new government would have to take on after a breakup witht the United Kingdom versus its anticipated oil revenues. Standard & Poor’s issued a nuanced assessment of how it would rate Scotland’s debt that noted the country’s economic wealth, which is largely based on oil and gas. But the report also raised concerns about the viability of Scotland’s financial sector in the absence of a reputable lender of last resort.

If an independent Scotland issued its own currency, it would be joining other north European countries that either do not belong to the European Union (Iceland, Norway) or have not adopted the euro (Denmark, Sweden). These countries have certainly suffered bouts of volatility and instability (particularly Iceland), but have not fared any worse than many members of the Eurozone. Their decision not to enter the Eurozone itself is interesting and worth further analysis.

But none of them is as deeply tied to another single country as Scotland is to the United Kingdom. Disentangling those ties for the purpose of establishing national autonomy would be difficult and most likely costly. Proclaiming monetary independence, therefore, would be a policy action that makes limited sense in economic terms but carries a great deal of nationalistic baggage. And those types of ventures do not usually end well.

Group Therapy

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Pop quiz: which U.S. policymaker said last week: “We can’t solve everyone else’s problems anymore” in response to foreign criticism of U.S. handling of what issue?

a—Federal Reserve Chair Janet Yellen, responding to criticism by foreign central bankers of the Fed’s tapering of its asset purchases;

b—Treasury Secretary Jack Lew, following denunciations of the refusal of the U.S. Congress to pass legislation that would enable IMF quota reform;

c—an anonymous White House aide, defending the Obama administration’s response to the turmoil in the Ukraine.

The correct response is c. But Ms. Yellen and Mr. Lew, who are attending the conference of G20 finance ministers and central bank heads in Sydney, might be forgiven if they held similar (but unspoken) sentiments.

The Federal Reserve has been criticized for not coordinating its policies with its peer institutions, particularly in those emerging markets that have had capital outflows and declines in equity market prices. But the critics have not spelled out precisely what they believe the Federal Reserve should do (or not do), given its assessment of the state of the U.S. economy. Domestic central banks respond to domestic conditions. In some cases, those conditions are linked to the global economy, and a central banker who ignored those linkages would only be postponing the implementation of stronger measures. But is that the case here?

The IMF came the closest to offering a specific criticism:

Advanced economies should avoid premature withdrawal of monetary accommodation as fiscal balances continue consolidating. Given still large output gaps, very low inflation, and ongoing fiscal consolidation, monetary policy should remain accommodative in advanced economies. There is scope for better cooperation on unwinding UMP, including through wider central bank discussions of exit plans.

Does anyone think that the Federal Reserve no longer intends to “remain accommodative”? Are more discussions the only missing element of the Federal Reserve’s plans? That would be surprising, since central bankers have many opportunities to speak to each other, and usually do.

The IMF did not let the emerging market countries off the hook:

In emerging market economies, credible macroeconomic policies and frameworks, alongside exchange rate flexibility, are critical to weather turbulence. Further monetary policy tightening in the context of strengthened policy frameworks is necessary where inflation is still relatively high or where policy credibility has come into question. Priority should also be given to shoring up fiscal policy credibility where it is lacking; subsequently buffers should be built to provide space for counter-cyclical policy action. Exchange rate flexibility should continue to facilitate external adjustment, particularly where currencies are overvalued, while FX intervention— where reserves are adequate—can be used to smooth excessive volatility or prevent financial disruption.

Critics are on firmer grounds when they criticize the U.S. for not passing the necessary legislation to change the IMF’s quota allocations. But perhaps they should not take their annoyance out on Mr. Lew. The U.S. Congress did not approve the needed measures for a number of reasons, none of them particularly compelling. Mr. Lew would be delighted to see the situation change, but that is unlikely to happen.

What, then, can be done at the G20 meeting? If allowing everyone to voice her or his frustrations with the U.S. serves some useful purpose, then all the air miles on the flights to Sydney will have been earned. Perhaps IMF Managing Director Christine Lagarde can serve as mediator/therapist. But before everyone piles on, it may be worth reflecting that the Federal Reserve is not the only central bank with policy initiatives that may ripple across national borders.

Been There, Done That

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President Barack Obama has nominated Stanley Fischer to the Board of Governors of the Federal Reserve Board, where he will succeed Janet Yellen as Vice-Chair of the Board. Fischer’s accomplishments are well-known. But he also brings an interesting set of credentials to the Board at a time when it has been criticized for ignoring the impact of its policies on other countries.

Fischer received his doctoral degree from MIT, and returned there after a stint on the faculty at the University of Chicago. During the 1970s and 1980s he taught or advised such future luminaries as Ben Bernanke, Greg Mankiw and Mario Draghi. He served as Vice President and Chief Economist of the World Bank from 1988 to 1990. He was the First Deputy Managing Director of the IMF from 1994 through 2001, a period when financial crises recurred on a regular basis in the emerging market countries.

Fischer’s experience with those crises gives him a perspective that macroeconomists who work only on the U.S. economy do not possess. Paul Krugman has written about how the financial instability of the post-Bretton Woods era has affected the views of those who follow these events. In 2009, for example, when our profession was castigated for not foreseeing the global financial crisis, Krugman wrote: “

…the common claim that economists ignored the financial side and the risks of crisis seems not quite fair – at least from where I sit. In international macro, one of my two home fields, we’ve worried about and tried to analyze crises a lot. Especially after the Asian crisis of 1997-98, financial crises were very much on everyone’s mind.

Similarly, in 2011 Krugman wrote:

Indeed, my sense is that international macroeconomists – people who followed the ERM crises of the early 1990s, the Latin American debt crisis, the Asian crisis of the late 90s, and so on – were caught much less flat-footed.

The IMF, of course, was widely criticized at the time for its crisis-management policies and its advocacy of deregulating capital flows. In retrospect, Fischer’s arguments in favor of capital account liberalization appear overly zealous, and he has drawn criticisms for those positions. The IMF has recently adopted a more nuanced position on the use of capital controls as a macro prudential tool.

And yet—in 2000, after the resignation of the IMF’s Managing Director Michel Camdessus, Fischer, who was born in Rhodesia (now Zambia), was nominated to be Camdessus’ replacement by a group of African nations. (Miles Kahler presents the story in his Leadership Selection in the Major Multilaterals.) This was a challenge to the European governments that had always claimed the prerogative of naming the Managing Directors of the IMF since it commenced operations in 1945. But the nomination was also an indication of the respect that Fischer enjoyed amongst the African and other developing countries. In the end, it was impossible to change the IMF’s traditional governing procedures, and Horst Köhler of Germany became the new Managing Director.

After Fischer left the IMF, he went to work at Citigroup. In 2005 he was appointed Governor of the Bank of Israel, and served there until last year. Under his leadership the Bank received praise for its policies. Fischer was widely admired and received an “A” for his stewardship from the magazine Global Finance. Those pouring through his recent speeches and writings for indications of what he might do as a Federal Reserve Governor believe that he endorses the Fed’s accommodative stance, but may have a nuanced approach on the benefits and costs of forward guidance.

Stanley Fischer, therefore, brings several attributes to the Federal Reserve. First, he has an unquestioned command of macroeconomics, and in particular, monetary policy. Second, he has a wealth of experience in dealing with financial calamities. And third, he earned the trust and respect of policymakers in developing nations while he served at the IMF. Those qualities will be much appreciated as foreign officials and financial markets deal with the Federal Reserve’s policy pivot.

Birds of a Feather

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Policy coordination on the international level is one of those ends that governments profess to aspire to achieve but only realize when there is a crisis that requires a global response. There are many reasons why this happens, or rather, does not. But in one area—monetary policy—central bankers have in the past acted in concert, and their activities provide lessons for the conditions needed to bring about coordination in other policy spheres.

Jonathan D. Ostry and Atish R. Ghosh suggest several reasons for the lack of coordination. First, policymakers may only focus on one goal at a time, and ignore intertemporal tradeoffs. Second, governments may not agree on the size of spillovers from national policies. Finally, those countries that do not participate in policy consultations do not have a chance to influence the policy decisions. Consequently, the policies that are adopted are not optimal from a global perspective.

All this was supposed to change when the G20 became the “premier forum for international economic co-operation.” The government leaders agreed to a Mutual Assessment Process, through which they would identify objectives for the global economy, the specific steps needed to attain them, and then monitor each other’s progress. How has that worked? Most observers agree: not so well. Different reasons are advanced for the lack of progress (see here and here and here), but the diversity of the members’ economic situations works against their ability to agree on what the common problems are and a joint response.

There is one area, however, where there has been evidence of communication and even coordination: monetary policy. What accounts for the difference? The linkages of global financial institutions and markets complicate the formulation of domestic policies. Steve Kamin has examined the literature on financial globalization and monetary policy, and summarized the main findings. First, the short-term rates that policymakers use as targets are influenced by foreign conditions. Second, the long-term rates that affect spending are also affected by foreign factors. The “savings glut” of the last decade, for example, has been blamed for bringing down U.S. interest rates and fuelling the housing bubble. Third, the financial crises that monetary policymakers face have foreign dimensions. Capital flows exacerbate volatility in financial markets, and disrupt the operations of banks (see here). Therefore, central bankers can not ignore the foreign dimensions of their policies.

The actions of monetary policymakers during the global crisis are instructive. In October 2008, the Federal Reserve, the European Central Bank, and several other central banks simultaneously announced that they were reducing their primary lending rates. The Federal Reserve established swap lines with fourteen other central banks, including those of Brazil, Mexico, Singapore, and South Korea. The central banks used the dollars they borrowed from the Federal Reserve to lend to their own banks that needed to finance their dollar-denominated acquisitions. The Federal Reserve also lent to foreign owned financial institutions operating in the U.S.

While the extent of their cooperation in 2008-09 was unprecedented, it was not the first time that the heads of central banks operated in concert. There are several features of monetary policy that allow such collaboration. First, monetary policy is often delegated by governments to central bankers, who may have some degree of political independence and longer terms of office than most domestic politicians. This gives the central bankers more confidence when they deal with their counterparts at other central banks. Second, central banking has been viewed as a more technical policy area than fiscal policy and requires professional expertise. In addition, the benign economic conditions associated with the “Great Moderation” gave central bankers credibility with the public that manifested itself in the apotheosis of Alan Greenspan. Third, central bankers meet periodically at the Bank for International Settlements, and have a sense of how their counterparts view their economies and how they might respond to a shock. A prestigious group of economists have proposed that a group of central bankers of systemically significant banks meets under the auspices of the Committee on the Global Financial System of the BIS to discuss the implications of their policies for global financial stability.

All this can change, and already has to some extent. Monetary policy has become politicized in the U.S. and the Eurozone, and even Alan Greenspan’s halo has been tarnished. Policymakers from emerging markets were caught off-guard by the rise in U.S. interest rates last spring and argued for more monetary policy coordination.

Are there lessons for international coordination on other fronts? The conditions for formulating fiscal policy are very different. Fiscal policies are enacted by legislatures and executives, who are subject to domestic public opinion in democracies. There is little consensus in the public arena on whether fiscal policy is effective, which can lead to stalemates. Finally, there is no common meeting place for fiscal policymakers except at the G20 summits, where there is less discussion and more posturing in front of the press.

The G20 governments enacted fiscal stimulus policies at the time of the crisis. Since then, the U.S. has been unable to fashion a coherent policy plan, much less coordinate one with foreign governments. The Europeans are mired in their debt crisis, and the G20 meetings have stalled. It is difficult to see how these countries could act together even in the event of another global crisis. Like St. Augustine’s wish for chastity, governments may want to coordinate their policies—but not quite yet.

Another Divergence

1944, 1976, 2013?

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When the financial crisis of 2007 was changing into the Great Recession of 2008-09, national leaders such as French President Nicolas Sarkozy and British Prime Minister Gordon Brown turned to the Bretton Woods conference of 1944 for inspiration. They invoked the spirit of the conference as they sought to resolve the crisis and devise regulations that would allow them to rein in the financial institutions that they held responsible for instigating the crisis. Indeed, Bretton Woods is often used as a model of international cooperation. (See, for example, here and here.)

But Bretton Woods is an odd choice for a prototype of international collaboration. Benn Steil in The Battle of Bretton Woods has shown how the conference proceedings were controlled by the U.S. delegation headed by Harry White, the U.S. Assistant Secretary of the Treasury. John Maynard Keynes, a member of the British delegation, was out-maneuvered by White, and the final agreement reflected the U.S. vision for the post-war international monetary regime more than anyone else’s. While the conference had a Quota Committee, for example, in reality the quotas assigned the members were chosen by the U.S. officials.

A more apt historical precedent may be the negotiations that took place during the early 1970s over the design of an international monetary system to replace Bretton Woods. Michelle Frasher has provided an account of these consultations in Transatlantic Politics and the Transformation of the International Monetary System. The U.S. had ended the conversion of gold for dollars by foreign central banks in August 1971. This act, according to Frasher, reflected the belief of U.S. President Richard Nixon and his Treasury Secretary John Connally that maintaining gold conversion limited their domestic and foreign policy options rather than any ideological view regarding Bretton Woods.

However, George Schultz, Connally’s successor as Treasury Secretary, came to favor floating exchange rates after the breakdown of the Smithsonian agreement in 1973. But while the U.S. had been able to dominate its Allies in 1944, it faced a different situation in the early 1970s. It could not ignore the wishes of its major European allies, France, West Germany and Great Britain, which were concerned about unconstrained markets. The French in particular sought to place restraints on the ability of nations to maintain floating rates. In the end, the U.S. and French negotiators agreed to amend the IMF’s Article IV to include a commitment by the IMF’s members “to assure orderly exchange arrangements and to promote a stable system of exchange rates…” The IMF is still struggling to explain what this means in terms of which practices are permissible and which are not.

Over three decades later, many of the same tensions persist. Now, however, it is China and other Asian countries that express concerns about the U.S. Frasher (p. 135), for example, describes the source of the Europeans’ resentment in the 1970s:

…the US tendency to behave paternally and use its reserve status to disregard European opinions, act unilaterally on major policy initiatives, frame the relations in terms of US interests, and dictate the conditions of international monetary reform constantly frustrated European views about partnership. The economic and political differences within the transatlantic alliance made for an unconstructive, uneven, and often tense partnership.

Substitute “Asian” for “European” and “transpacific” for “transatlantic,” and we have a good summary of the Asians’ current views of the U.S. For example, Justin Yifu Lin, a former Chief Economist of the World Bank and the founding director of the China Center for Economic Research, wrote in Against the Consensus: Reflections on the Great Recession (p. 156)

One of the main flaws in the nonsystem that evolved in the post-Bretton-Woods period eventually led to the 2008-9 global crisis: the potential conflict of interest between US macroeconomic policy for domestic objectives and the dollar’s role as a global reserve currency…Inevitably, national economic concerns guided US fiscal and monetary policies, at times in ways that were detrimental to global stability.

Similarly, Xu Hongcai of the China Center for International Economic Exchanges in an article in the Global Summitry Journal co-authored with Yves Tiberghien wrote (p. 10):

Despite the status of the US as anchor for the global monetary system, the US central bank, the Federal Reserve is strictly mandated to set its monetary policy with consideration for US inflation, growth, and employment only. There is no channel for inputs from the rest of the world in managing the world’s currency. Thus, the major international reserve currency issuer continues to implement quantitative easing monetary policies in light of the needs of its own economy without considering the global spillover effect of such policies. These policies have caused inflationary pressures on emerging economies, and in turn increased the systemic risks of the global financial system.

After 1976, France gave up trying to devise a rule-based global system and turned to a regional system. What are China’s options? It has already shown a willingness to join with other Asian nations in a currency swap arrangement, the Chiang Mai initiative. It has the potential to do more, and could become a regional reserve currency. But to increase the use of the renminbi would require further financial decontrol, and until recently it did not appear that the government was ready to move in that direction. Most observers thought that a “fully global renminbi was a distant goal.”

The political battles over the debt ceiling, however, may push the Chinese government to rethink its long-run plans for the renminbi. Chinese officials expressed their frustration with the indifference of the U.S. to the global consequences of its domestic political discord. If Chinese policymakers now advance their timetable for expanding the renminbi’s use as a global currency, we may look back at 2013 as an inflection point.

Capital Ebbs and Flows

Global Finance and How It Shapes Our World

Tag Archives: central banks

Dilemmas, Trilemmas and Difficult Choices

Tales of Globalization: Russia and China

Tapering and the Emerging Markets

High Road, Low Road

Group Therapy

Been There, Done That

Birds of a Feather

Another Divergence

1944, 1976, 2013?